Co-lending or co-origination is a set-up where banks and non-banks enter into an arrangement for the joint contribution of credit for priority sector lending. To put it simply, under this arrangement, both banks and NBFCs share the risk in a ratio of 80:20 (80 percent of the loan with the bank and a minimum of 20 percent with the non-banks).
In recent times, banks and NBFCs embarked on increasing the co-lending tie-ups. IIFL Home Finance recently tied up with Punjab National Bank. It already has three existing tie-ups with Central Bank of India, ICICI Bank and Standard Chartered Bank.
Listed non-bank lender U Gro Capital tied up with IDBI Bank and Kinara Capital, an NBFC funding small and medium businesses. Gold loan NBFC Indel Money tied up with IndusInd Bank to offer gold loan in a co-lending format. Recently, Bank of India entered into an arrangement with MAS Financial Services.
Small Business Finance (SBFC), an NBFC lending to small businesses, was one of the first NBFCs to co-originate loans with ICICI Bank in 2019.
Here we try to explain what is a co-lending model, challenges, opportunities and the way forward:
Q. How does a co-lending model work?
The Reserve Bank of India (RBI) had come out with the co-origination framework in 2018 allowing banks and NBFCs to co-originate loans. These guidelines were later amended in 2020 and rechristened as co-lending models (CML) by including Housing Finance Companies and some changes in the framework.
The primary aim of CLM is to improve the flow of credit to the unserved and underserved segment of the economy at an affordable cost. This happens as banks have lower cost of funds and NBFCs have greater reach beyond tier-2 centres.
As per RBI norms, a minimum 20 percent of the credit risk by way of direct exposure shall be on NBFC’s books till maturity and the balance will be on the bank’s books. Upon maturity, the repayment or recovery of interest is shared by the bank and NBFC in proportion to their share of credit and interest.
This joint origination allows banks to claim priority sector status in respect of their share of credit. NBFCs act as the single point of interface for the customers and a tripartite agreement is done between the customers, banks and NBFCs.
Q. What took so long for co-lending to take off?
On several occasions, the Ministry of Finance has pushed for PSU banks to adopt co-lending models. Some of the PSU banks in the initial days had tied up with large non-banks. For instance, SBI had tied up with ECL Finance, a subsidiary of Edelweiss Financial Services in September 2019.
But some of these tie-ups didn’t take off as expected. According to bankers, banks and NBFCs both are open for these kinds of tie-ups but the challenge was in execution at ground level.
Some of the main hurdles were IT integration of systems as both banks and NBFCs would operate on different systems, different underwriting processes and parameters. All of these took a lot of time to solve for the marriage to happen.
Amit Sharma, MD & CEO, Satin Housing Finance Limited, said, “Beyond technology challenges, longevity of the relationship is yet to be seen.”
The co-lending model is still in the nascent stages and one may enter into an agreement but over a period of time the relationship should sustain, Sharma added.
A senior banker with a private sector bank explained that most of these arrangements are with NBFCs that have sizable distribution but are low on capital. Most of the mid-sized well-rated NBFCs still opt for term loans over entering into co-lending models, given the complexities around integration and processes.
Q. What are the opportunities?
The co-lending model if it takes off and is executed rightly will ensure delivery of credit to the unserved and underserved, said a senior executive at a mid-sized NBFC.
The real gap of credit exists with the segments such as small and medium businesses, credit to lower and middle-income groups, rural areas, etc., he added.
The opportunity can be taken up by digital lending start-ups and mid-size NBFCs, and they can actually marry their strength of distribution with bank’s funds, Sharma said.
As banks are flushed with funds, they can cater to vast customers as NBFCs have reach in tier-3 and tier-4 cities. On the execution side, it really needs to be tested at ground level, Sharma adds.
Q. What is the way forward?
According to experts, to address the huge credit gap the co-lending model is one of the right ways to go forward, but challenges around tech integrations and ground-level executions should be addressed.
The country’s largest lender, SBI, recently said it is actively looking at co-lending opportunities with multiple NBFCs / NBFC-MFIs for financing farm mechanisation, warehouse receipt finance, farmer producer organisations (FPOs), etc., for enhancing credit flow to double the farmers’/individuals’ income.
The bank entered into a co-lending agreement with Vedika Credit Capital Ltd (VCCL), Save Microfinance Pvt Ltd (SMPL) and Paisalo Digital Ltd (PDL).
Finance Minister Nirmala Sitharaman in her recent visit to Mumbai in August met MDs of PSU banks. She said that the focus should be towards credit growth to support MSMEs and underserved segments.
In her interaction with state-run banks, Sitharaman emphasised the necessity of making the co-lending model work to enhance affordable credit to MSME and retail sectors.
According to experts, as the economy recovers coupled with pent-up demand, these kinds of models will evolve and grow to fulfil the credit requirements of the priority sector segments.
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